Stand with Rand in liberating credit-union lending

John Berlau Senior Fellow, CEI
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Any bill that is sponsored by Sens. Mark Udall (D-CO) and Rand Paul (R-KY), or any similarly odd ideological couple, more than meets the definition of bipartisan. But the Udall-Paul bill, S. 968, should be cheered not just because of its bipartisanship, but because it actually spreads freedom. Those concerned with government eroding options for entrepreneurs should cheer this legislation, which lifts regulatory barriers to an untapped source of capital for start-ups: America’s credit unions.

Small businesses and start-ups pursue many diverse sources of funding. As traditional sources have dried up, credit unions have stepped in to fill the void. As Rohit Arora, CEO of the Biz2Credit small business loan arranging service, recently explained at FoxBusiness.com, “Following the mortgage bust, many big banks essentially turned off the spigot to small business lending. Credit unions decided to take advantage of this hole in the marketplace by increasing their small business loan-making.”

But because of government barriers to credit-union business lending, thousands of entrepreneurial ventures may be unnecessarily deprived of the seed capital credit unions could provide to them. As Arora says, “Credit unions are handcuffed by a lending cap of 12.25 percent of their assets imposed by the Credit Union Membership Access Act of 1998. Thus, many of those who became active in small business lending quickly hit their limit.”

And this regulatory barrier is exactly what Udall-Paul — and its House companion H.R. 688, sponsored by Rep. Ed Royce (R-CA) — would fix. The legislation would raise the cap for business lending to 27.5 percent of a credit union’s assets. The modest hike in the lending cap would pay big dividends for entrepreneurs and the economy. The Credit Union National Association estimates this increase in the cap would create 138,000 jobs in the first year, a figure Pepperdine University economist David M. Smith calls “conservative and well within the bounds of a reasonable projection.”

The bills don’t go far enough; the cap should be eliminated entirely. There’s no “lending cap,” for instance, for credit unions in making car loans and home mortgages — even though, after the financial crisis, it’s hard to say business loans are any more inherently dangerous than mortgages. National Credit Union Administration Chairman Debbie Matz, an Obama appointee, told the House Financial Services Committee last year that business lending “did not have a major impact on the safety and soundness of the vast majority of credit unions” during the downturn, and that an increase in business lending is “another way in which to prudently manage risk.”

The only real opposition to the idea is coming from the powerful bank lobby, both from the big banks and from a trade association that purports to speak for smaller ones — the Independent Community Bankers of America (ICBA).

But the ICBA has a history of selling out its member banks. As reported by Robert Kaiser in his new book “Act of Congress” (and in an excerpt that ran recently in the Washington Post), ICBA President Camden Fine entered into a secret-handshake agreement with then-House Financial Services Committee Chairman Barney Frank (D-MA) during the financial reform debate in 2010. Fine agreed to “stay silent” on much of Dodd-Frank until it passed. In return, Frank changed the deposit insurance assessment formula in a way that benefits small banks. But by any reasonable estimate, the costs that Dodd-Frank imposed on community banks have swamped any savings from the change to the deposit insurance assessment formula.

Before they jump on the ICBA’s pro-regulation bandwagon, community banks should think long and hard about which is the greatest threat facing them — credit unions or Dodd-Frank. The answer should be an easy one. As Ammon Simon wrote recently in National Review, “In Florida, 96 percent of community banks and credit unions expect to spend considerably more time and money on compliance with new federal regulations over the next three years, while 64 percent expect to hire new compliance staff and reduce their lending.”

As Simon noted, Dodd-Frank is a big anvil weighing down credit unions as well as community banks. But unlike the ICBA, the main credit-union associations have shouted their criticisms of the law from the hilltops. At a recent congressional hearing, Robert D. Burrow, president and CEO of the Bayer Heritage Federal Credit Union in Proctor, W.Va., testified that “the breadth and pace of [Dodd-Frank] rulemaking is troublesome as the unprecedented new compliance burden placed on credit unions has been immense.”

Banking lobbyists also criticize the perceived tax advantage of credit unions, but this benefit is exaggerated and largely irrelevant to whether it’s wise policy to lift restrictions on credit unions’ ability to make business loans. Credit unions are exempt from some forms of corporate taxation because they are member-owned cooperatives that don’t have the many means of raising money that banks do (such as the issuance of shares of stock). Credit-union members, however, are fully taxed on the dividends on their accounts, and are taxed at the ordinary income-tax rate for interest, rather than the lower rate for dividends.

Conservatives and libertarians have long argued that business income should only be taxed once, and credit unions provide a successful example of a single-taxation model. Some smaller banks are also eligible to be incorporated as subchapter S corporations, a single-taxation structure very similar to that of credit unions. In any case, it’s a bit rich for the nation’s banks — big or small — to complain about unfair subsidization after they received more than $1 trillion in taxpayer largesse from TARP and other bailouts.

So let’s support Sens. Udall and Paul in lifting the foolish barriers to business lending by credit unions. While we’re at it, we should go after all unnecessary barriers to lending that are holding back the economy and its entrepreneurs.

John Berlau is senior fellow for finance and access to capital at the Competitive Enterprise Institute.